Beware California's hidden cell phone tax

David Lazarus

Published 4:00 am, Friday, May 6, 2005

Gillian Cropp, a San Francisco medical researcher, ordered a new cell phone from Nextel. When it arrived in the mail the other day, she discovered that she owed $74.99 for the handset (which she expected) and $19. 12 in sales tax (which she did not).

That's a nearly 25 percent tax.

Or is it?

Cropp learned -- after wading through a series of Nextel service reps - - that despite paying a discounted amount of $74.99 for her phone, she was being taxed for the more than $200 full retail price.

"I was incensed," she said. "If you get a reduction on the price of a car, you don't still pay taxes on the full price. It's not right."

It is, however, a California regulation.

Moreover, that regulation may itself violate state law, making the charging of these high sales taxes illegal. We'll get back to that after a closer look at why wireless customers are being hit with sky-high sales taxes.

Regulation 1585 of the state code on sales and use taxes specifies that all cell phones will be taxed at the full retail amount, regardless of the price paid as part of a special offer.

The agency, which collects a total of about $38 billion in annual sales and use taxes, decided that price reductions by wireless service providers shouldn't affect how much the state can pocket every time a cell phone is sold.

"The phone is worth a price," Gore said. "It's discounted if you buy a service plan. That doesn't make the phone worth any less."

Such thinking may be fine for deficit-running state officials, who need all the revenue they can get their hands on. But where does it leave consumers?

As usual, pretty much on their own.

"It's up to customers to watch for this," said Michael Shames, executive director of the Utility Consumers' Action Network in San Diego. "Typically, this won't be disclosed by the carrier as part of their terms and conditions when you get your phone."

Verizon Wireless is one of the few providers that does disclose in the fine print of ads and on signs in stores that sales taxes are based on the full retail price of the handset.

On the other hand, ads running in newspapers this week for Nextel are more typical of the way most cell phones are marketed. They feature a Motorola phone that's being offered for free if a customer signs up for two years of service at $49.99 a month.

What the ads don't say is that the full retail price of that handset is $149.99. In San Francisco, where consumers pay a sales tax of 8.5 percent, that ostensibly free phone will in fact come with a levy of $12.75.

Sales taxes vary slightly from county to county.

Matt Sullivan, a Nextel spokesman, acknowledged that the company doesn't disclose in its marketing that California customers will be required to pay a sales tax at the full value of a handset.

"We realize this may cause some confusion," he said, adding that the company may revise its invoices to better reflect the state regulation.

Another potentially confusing element here is that the state regulation appears to contradict separate statutes in the California Revenue and Taxation Code.

Section 6006 of the code defines a sale as "any transfer of title or possession, exchange or barter, conditional or otherwise, in any manner or by any means whatsoever, of tangible personal property for a consideration."

Meanwhile, Section 6051 says a sales tax will be imposed on "the gross receipts of any retailer from the sale of all tangible personal property sold at retail."

Charles Moll, a tax attorney in the San Francisco office of law firm Morrison & Foerster, said these two sections make clear that a sale transpires when a customer purchases a good, and that the sales tax pertains solely to the price paid during that transaction.

"The tax is not imposed on the value of an item," he said. "It's imposed on the retail price you pay -- the consideration that the customer pays to the retailer."

In the case of cell phones, Moll said, Section 6051 indicates that the customer is responsible for paying a sales tax only on the price charged by the wireless provider, discounted or otherwise.

As a result, he said, the Board of Equalization's regulation on taxation of cell phones shouldn't apply. "I believe the regulation is invalid," Moll concluded.

The Board of Equalization's Gore responded by citing yet another section of the tax code, Section 6012.

It defines "gross receipts" as "the total amount ... of the retail sales of retailers, valued in money, whether received in money or otherwise."

Those last two words, Gore said, are the key when it comes to cell phones.

"The 'or otherwise' is the service plan," she said. "You don't get the phone (at a discount) if you don't take the service."

Roy Crawford, a tax attorney in the San Francisco office of law firm Heller Ehrman, said he agrees with the agency's thinking. "It's a fair defense, " he said of Section 6012.

"The question is whether part of the service plan is going to the cost of the phone," he said. "It's actually a separate thing."

Moll observed that if the service plan in fact represents a portion of the handset's true value, then the cost of the plan should go down if you tell the wireless provider you don't want a new phone.

"Is this going to happen? No," he said. "You have to pay the monthly service fee whether or not you get the phone. Clearly, the service fee has nothing to do with the cost of the phone."

Ken Muche, a Verizon spokesman, confirmed that most service plans don't recoup the cost of handsets.

"We subsidize part of the price of the phone," he said. "It's a loss for us."

In any case, Gore at the Board of Equalization said her agency is comfortable with the sales tax and will continue imposing the charge on consumers until a court says it can't.

"The regulation allows us to implement the law in this way," she said. "It's never been challenged."

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